Monetary Shocks and Stock Returns: Identification Through the Impossible Trinity

49 Pages Posted: 22 Sep 2013

See all articles by Ali K. Ozdagli

Ali K. Ozdagli

Federal Reserve Banks - Federal Reserve Bank of Boston

Yifan Yu

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: September 1, 2013

Abstract

We present evidence of significant bias in event studies that investigate the effect of U.S. monetary policy on U.S. stock prices. To overcome this bias, we propose a new identification method based on the "Impossible Trinity" theory which argues that an economy with a fixed exchange rate and free capital flow cannot have an independent monetary policy. As an application of this method, we study U.S. monetary policy changes as exogenous shocks to the Hong Kong stock market. We find that a 1% (100bp) surprise decrease in the federal funds target rate increases stock prices by about 5%.

Keywords: stock prices, monetary policy, simultaneity, omitted variables, Impossible Trinity

JEL Classification: E4, E44, E5, E52, E58, F3, F33, G1, G12, G15, G18

Suggested Citation

Ozdagli, Ali K. and Yu, Yifan, Monetary Shocks and Stock Returns: Identification Through the Impossible Trinity (September 1, 2013). Available at SSRN: https://ssrn.com/abstract=2328966 or http://dx.doi.org/10.2139/ssrn.2328966

Ali K. Ozdagli (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

HOME PAGE: http://sites.google.com/site/ozdagli/

Yifan Yu

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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